What may sound like a complex exercise that drums up fear in the business owners who need to understand it, financial forecasting explained in layman’s terms highlights just how vital a role it plays in driving any business forward.
Financial forecasting is a prediction of future business conditions likely to affect your business.
A financial forecast identifies trends in historical data, generated from both inside and outside your business, to provide an accurate insight on how your business’ financial status will be at a range of different points in the future.
To fully understand your financial position, there are generally three things you need to consider - your profit and loss statement, balance sheet and cash flow.
The above trio show you how your business has performed to this point in time. In analysing them properly, they will also give you great insight into the future and what changes, if any, you need to hit your business objectives.
Your financial forecast is generally updated on a regular basis, preferably every month, and gives you a real-time view of what you expect to happen based on the most recent events.
Whatever your precise purpose is for using a financial forecast, it is vital to any business in search of success for several reasons, as discussed below.
If you aim for nothing, that’s probably what you’ll get. A financial forecast is a roadmap of what you’re aiming to achieve and how you intend to get there. It provides a lot of insight as to the resource requirements and milestones needed to reach your goals.
A financial forecast is to a business what a detailed map is to a sailor - without it, it’s unlikely you’ll navigate the choppy waters of the business world on your way to success.
If you don’t have a financial forecast, don’t be surprised if you feel like you’re getting nowhere.
Survival in business requires lots of checking in against your planned course, reading the instruments and making adjustments on a fairly regular basis.
Sometimes it can pay to be a little bit paranoid.
Comparing your financial forecast against your actual results and monitoring any changes provides the valuable insight required to make effective changes and set your business back on track.
The accuracy and correctness of your decisions are largely dependent on your true understanding of your business position.
Reliable management accounts, in addition to financial forecast, ensure you’re always up to speed on your business position. This will allow you to make informed decisions that will benefit your business both now and in the long run.
If you are working with accurate forecasts, you will be able to learn from the past and more accurately predict the future. It will also keep you looking ahead, making you more likely to foresee market changes and competitive challenges.
A financial forecast plays an important role in calculating the financial needs of your business.
Whether it be fixed or working capital, financial forecasting will help you make the accurate predictions about what your business needs to succeed.
If your business is expanding, further capital may be needed for your new venture. In this scenario, you’re required to have a good idea of what capital will be required to be successful.
A well-built financial forecast will highlight the key drivers of your business.
Once you have a financial model with clear key drivers, you should then be able to change those to see what impact that has on the results you’re trying to achieve.
It is often useful to introduce sensitivities into your forecasting and have at least best, worst and expected scenarios.
Cash flow has a great influence on the success of your business, and if not properly managed, can start controlling your operations and decisions.
Accurate forecasting helps you better manage that cash flow, anticipate and mitigate problems early on.
Does your business have a robust and reliable financial forecast in place? If not, get in touch with our team to discuss how we can create a bespoke financial model, specifically designed to drive your business’ performance.